Sunday, December 09, 2012

A 21st Century blueprint for taxing multinational companies

Today's Observer newspaper in Britain carries an article about TJN's new report on taxing transnational companies, in which Professor Sol Picciotto makes the case for shifting to unitary taxation with profits being apportioned to the various countries in which the TNCs have a genuine economic presence.

Sol's report is available in full hereand you can download the press release here.

The Tax
Justice Network on Sunday 9th December will unveil a blueprint for a
21st century system for taxing multinational companies to replace
the current outdated and thoroughly discredited model.

Rampant international
corporate tax abuse means it is now beyond doubt that many of the governing
principles underpinning international tax are fundamentally flawed.

In the face
of rising public anger, governments are promising to fix the problems, but
their proposals so far involve trying to patch up an outdated international
system that is beyond repair.

Failings built
into the current system let large multinationals avoid hundreds of billions of
dollars in tax.

Thanks to
their tax subsidies, multinationals out-compete smaller locally-based rivals.
This has nothing to do with genuine economic efficiency or productivity. They
are killing off their smaller rivals in markets, and at the same time free riding
on the tax-funded benefits provided by the societies where they operate, letting
others pick up the tab.

This can no
longer be tolerated.

As
politicians scramble to placate the public at the sheer size of tax dodging by all
sectors of international business including global extractive, finance and new technology
firms, TJN today publishes, Towards
Unitary Taxation of Transnational Corporations by Sol Picciotto, emeritus professor at Lancaster University
and senior adviser with Tax Justice Network.

Towards Unitary Taxation of
Transnational Corporations is a roadmap outlining
a complete and managed overhaul of international system of corporation tax.

There is, we
believe, no alternative to wholesale reform of multinational taxation. The
status quo, left unchecked, will foment increased economic and social
dislocation.

“George Osborne claims that the UK
is taking the lead in looking for ways to deal with tax avoidance by TNCs. Yet
British officials have consistently opposed examining the necessary fundamental
reforms, especially unitary taxation, both in the European Union and worldwide.
If Osborne is serious, he must now back the necessary reforms to what is
clearly an unworkable system.

“The
only rational way to tax modern multinational companies is to tax them
according to where their genuine economic activity is, rather than where their
tax advisers pretend it is. The way to do this is to treat them as unitary
businesses that are much more than the sum of their parts – which is exactly
what they are. Their worldwide profits should be assessed by disregarding the
shifting of profits into artificial entities dreamed up by their tax planners,
and instead by apportioning those worldwide profits among the relevant
countries based on factors that reflect where their real business lies.
Countries can then tax their share of the worldwide profits at their own rate.”

John Christensen, director of Tax
Justice Network

“The OECD must now abandon its
efforts to tweak the outdated arm's length method which dates back to a bygone
economic era. Multinational companies dominate the global economy, and their
profits should be apportioned to the countries where real economic activity
occurs, rather than shifted to tax havens, as the current OECD rules permit.
The unitary tax is the logical approach for the 21st century, and we call
on the OECD to catch up with the programme.”

Today’s
international tax rules, which were drawn up nearly a century ago, have not
kept pace with the massive changes in the world economy.

The system
is governed by two broad principles. First, it treats transnational corporations (TNCs) as if they were loose collections of
separate entities operating in different countries. Because there is only weak
co-ordination between tax authorities, however, this ‘separate entity’
approach allows TNCs scope to shift profits around the globe to escape tax.

Second,
entities within a multinational trade with each other across borders at prices
governed by the so-called Arm’s Length Principle (ALP) – as if they were
independent actors trading with each other in the open market.

Yet TNCs enjoy
unique global synergies and advantages that come from combining economic
activities on a large scale and in different locations. These advantages cannot
be attributed to a single location, but to the whole global entity. So treating
each affiliate as a separate entity for tax purposes is impractical and does
not reflect economic reality; and their internal cross-border trades typically
bear no relation to any supposed “arm’s length” trade between independent
actors in an open market. It is, as a top U.S. tax expert puts it, “delusional”
to think this principle can be applied effectively.

This
international tax system is dominated by the Organisation of Economic
Cooperation and Development (OECD). The OECD’s Fiscal Committee, consisting of
unelected state officials, presides over an increasingly complex set of rules
which they are also responsible for applying. Its often arbitrary decisions
involve billions of dollars of taxes – yet it is effectively unaccountable.

This press
release introduces a new report, Towards
Unitary Taxation of Transnational Corporations by Sol Picciotto, emeritus professor at Lancaster
University, senior adviser with Tax Justice Network and author of International Business Taxation (1992), and Regulating Global Corporate Capitalism (2011).

A historical section charts
howthe international tax rules,
despite significant opposition and viable alternatives, were established in the
early 20th century, at a time when TNCs were in their infancy and loans
were the main form of international investment. As TNCs became more dominant in
the second half of the century, however, they increasingly took advantage of
the ‘separate entity’ principle to set up affiliates in convenient low-tax jurisdictions
(tax havens,) to cut their taxes.

In response,
increasingly diverse and complex and rules have been elaborated to patch up the
system, which has consequently become ever more arbitrary and opaque.

Many experts
now argue that a fresh approach is needed, starting from a recognition that TNCs
are not loose collections of separate entities but operate as integrated
businesses under central direction. This approach, which a majority of U.S.
states (and many others) already use successfully, is known as Unitary
Taxation.

It is time
for a system fit for the 21st Century to be rolled out
internationally. The paper outlines how the change could be phased in quite
quickly.

Unitary Taxation and Profit Apportionment

Instead of the
current system where multinationals are taxed according to the legal forms that
their tax advisers conjure up for them, unitary taxation would see TNCs being taxed
according to the genuine economic substance of what they do and where they do
it. This not only fits economic reality and is a far more legitimate basis for
international tax, but it is much simpler to administer, a particular benefit
for developing countries.It would massively
reduce tax abuse and dramatically curb TNCs’ use of tax havens, thus removing
much of the political cover protecting these secretive jurisdictions, and consequently
making them easier to deal with on secrecy and a wide range of other issues.

Under
unitary taxation a TNC engaged in a unified business submits a single set of
worldwide combined or consolidated accounts, in each country where it has a
business presence. This overall global profit is then apportioned to the
various countries, using a formula that reflects the TNC’s genuine economic
presence in each country. This allocation is often called ‘formulary
apportionment’ or, much better, ‘profit apportionment’. (The formula typically
considers the TNC’s assets, labour and sales in each jurisdiction.) Each
country involved sees the combined report and can then tax its portion of the
global profits at its own rate. Widespread international co-ordination is not
necessary for this to work, though it would help.

Unitary
taxation would place on a sounder basis the `territorial’ principle, where
profits are supposed to be taxed by the countries in which the business
activity takes place. This apportionment would be done according to factors
measuring real economic presence in each territory, rather than according to
the fictional devices and entities devised by the fertile minds of highly paid
lawyers and tax advisers.

Tax experts
have long known that this unitary approach makes more sense. It has long been
applied in federal systems, notably in the United States: a pioneer was the
State of California which was missing out on revenues thanks to Hollywood film
studios siphoning profits through their use of Nevada incorporated affiliates.

But the
approach has not yet been rolled out internationally. Indeed it has not even been seriously studied
by the closed groups of tax specialists running the system. Powerful vested
interests support the current system.

Preparing the ground

Even in the
1930s when the “separate entity” approach was first agreed internationally it
was accepted that in practice national authorities could look at the firm’s
overall financial accounts in order to ensure a fair split of the total
profits. However, this was never done in a systematic way but through this
increasingly complex array of often ad hoc, unworkable methods.

Some
techniques allowed by the OECD already go a fair way towards profit
apportionment, the basis for unitary taxation. Indeed, the European Union has already
prepared proposals for adopting a version of unitary taxation,[1] though
with a restricted scope.

one or more
major international trading blocs adopting the change. The EU project could be
the first. Its scope could be steadily expanded.

OECD under fire

The OECD has
for decades stubbornly refused even to consider the viability of the approach,
strongly influenced by lobbying, such as in a campaign led by British TNCs in
the early 1980s against worldwide profit apportionment by US states, especially
California. The system is also defended by a large and growing avoidance
industry including the Big Four accounting firms, which derive large fees
helping TNCs navigate the increasingly complex arena of international tax. TNCs
defend what they know is a dysfunctional system, because it helps them avoid
tax. The OECD
Committee, for its part, consists of national tax officials working closely
with private sector tax specialists and advisers from large accounting firms
with a vested interest in the status quo. Officials often leave public service
to take up lucrative private sector jobs, in a revolving door; each has invested
huge intellectual capital in understanding the complex rules they helped devise
- so they are understandably reluctant to reform the system.The OECD says
its Arm’s Length Principle (ALP) expresses an international consensus and
deploys it to close down debate elsewhere, especially in the UN Tax Committee,
which is potentially an alternative forum for setting international tax rules.

Developing
countries hope to tackle TNCs’ international tax strategies, but they find the
ALP difficult or impossible to administer in practice. India has 3,000 cases
challenging transfer pricing adjustment pending before its tax courts. Brazil
has modified the rules in ways the OECD disapproves of. China is taking a
similarly independent-minded approach. Persisting with this failing system of rising
complexity is a recipe for international conflict.Meanwhile,
banks and other financial firms are the main users of the tax haven system:
their systematic tax avoidance, by reducing their cost of capital,
significantly contributed to the liquidity that fuelled the speculative bubble
which resulted in the financial crash.

Until now, tax
authorities have not pushed for a unitary approach because they have felt that
political will is lacking. So instead they take upon themselves the
responsibility for deciding, on a case-by-case basis, how each large company
gets taxed.

That
political will is now within reach. The time has come to reform international tax
for the modern era.

Notes to Editors

• It is impossible to calculate the amount of money multinationals avoid globally not least because there is no agreement over what constitutes avoidance. In the UK, the TUC estimated 700 of the largest corporations avoid tax worth £13bn.• This approach has been widely endorsed. See Sol Picciotto and Nicholas Shaxson recently in the Financial Times. See Respected finance thinker John Kay, also in the Financial Times, who commented: “The repeated revelations that many major companies pay little or no tax, even if they do so by legal means, fuels a public sense that tax is mainly for little people. We need only look at Greece to see how socially, politically and economically corrosive that perception can be. . . . Well conceived apportionment is the best – perhaps only – answer to the problem presented by multiple company tax jurisdictions.” See also this FT editorial, also endorsing the concept.• Please click here for a series of quotes about the scale of tax abuse through TNC’s use of transfer pricing.

[1]
Common Consolidated Corporate Tax Base, or CCCTB, currently under consideration
by the European Council.

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About Me

The Tax Justice Network (TJN) is an international, non-aligned network of researchers and activists with a shared concern about the harmful impacts of tax avoidance, tax competition and tax havens.
www.taxjustice.net